Tuesday, December 18, 2018

Daily Writing

Things I’m thinking about

What will the world start to look like in the event of a liquidity crisis?

Market Observations

Major indexes traded higher at the start of the day. S&P and NASDAQ are both up 1.00%. However, the VIX[2], which is a gauge of fear in the market and trades inversely to the market, is only down 1.84% at the time of writing.

US Treasury yields continue to plummet. The yield on the 10-year Note sits at 2.85% while the yield on the long-dated 30-year Treasury Bill is 3.10%. WTI crude is down another 2.61% after dropping more than 3.50% yesterday.

The yield on the 10-year Japanese Government Bond (JGB) is threatening to move negative. The yield on 10-year JGB is now 0.01%. The Yen has also strengthened over the past few days. The USD/JPY cross-pair now trades at 112.500, 100 basis points off the highs a few weeks ago.

Despite heavy criticism from President Donald Trump, the Fed still intends to raise interest rates tomorrow (December 19). There are two key things to note here:

1) It is not normal for the US President to openly attempt to influence the interest rate policy of the Federal Reserve. The Fed is intended to exist as an independent body immune from political sway.

2) It is unusual for the Fed to raise rates in an environment where global growth appears to be slowing

China: Forty Years After Economic Reforms

Why is this significant?

Confidence in Xi, the regime, and the principles of “socialism with Chinese characteristics” are under threat. Chinese elites are really the only ones aware of this.

China’s leadership tends to be extremely cautious when making any public statements, so whenever a Chinese President makes an address like this, it tends to be big news.

The 40th-anniversary speech is especially significant because Xi Jinping revealed some revisions to his core position on two fronts:

Internal Chinese Communist Party politics and Chinese domestic policy

Foreign policy, especially regarding its stance toward the United States and on-going trade tensions between the two superpowers.

Internal Communist Party Politics and Chinese Domestic Policy

Xi Jinping has been transparent in his intention to consolidate both his power as General Secretary of the CCP along with his place in the history of communist China post-1949. In October of 2017, President Xi eliminated Presidential term limits and pushed to include his own version of Chinese socialism into the official party canon. Now he’s looking to overtake the legacy of revolutionary hero Deng Xiaoping. Deng Xiaoping is widely regarded as the father of modern China, as his reforms in the late 1970s and early 1980s are the catalysts behind China’s massive economic expansion over the past forty years.

Foreign Policy

Because the 40th anniversary of reform speech is one of Xi’s most high-profile public addresses since his meeting with President Trump at the G20 Summit in Buenos Ares at the beginning of the month, China watchers and analysts are following Xi’s speech closely, seeking clues into potential shifts in China policy.

Summarizing China

Our view is that China doesn’t have as much flexibility as it seems. China is dead-set on a shift toward re-orienting its economy to one based on consumption instead of investment. This means China would experience substantial growing pains even within an ideal economic climate.

Now, in the face of what could be a severe global economic slowdown, China has no choice but to capitulate to the demands of the Trump administration on trade in the short term. It’s doing this because it doesn’t want global attention toward the real problem, the fact that China is currently operating on an economic model that is no longer sustainable; namely, a model driven by export-led growth, infrastructure development, and massive imports of raw materials from developed neighbors such as Australia.

Can China fix its domestic problems before the next global slowdown really begins to take hold? According to my sources in China, the central government is facing a true crisis of confidence.

Wednesday, December 5, 2018

Daily Writing

Market Overview

Markets are closed today for a National Day of Mourning in honor of late President George HW Bush. Markets will reopen on Thursday.

Investors are still reeling from the sudden 3.00% drop in U.S. equities on Tuesday. There are indications that China is actively looking to cooperate more with the United States, but there is no telling what that means for the markets when we resume trading at 9:30 AM on Thursday.

Little questions I’d like to answer eventually

What does an inverted yield curve mean for the broader economy?

The price of palladium has exceeded the price of gold for the first time in 16 years. What does this mean? Why is this important? Who does this impact most? What is the use case for palladium?

China and Trump and America and trade wars, etc.

Following President Donald Trump’s open questioning of China’s commitment to reduce tariffs on US imports, China’s ministry of commerce stated publicly that it is committed to a 90-day timeline to address specific items.

Global markets cheered the weekend accord on Monday, only to reverse course Tuesday as doubts emerged over precisely what the world’s two largest economies had agreed on.

There is no good indication of how markets will respond to news that China’s ministry of commerce confirmed their 90-day commitment to purchase US imports and move to reduce or entirely remove tariffs within 90 days of December 1.

Government Bonds (German ones specifically)

The yield on the German 10-year government bond (also known as “the Bund” has fallen to 0.27%.

Why is this important?

When it comes to bonds, price and yield move inversely. When the price of a bond moves higher, the yield moves lower. Declining bond yields in the German Bund (or other comparably safe assets such as U.S. Treasuries) indicate that global investors are seeking safer assets to park their money. For example, if European investors are starting to feel uncertain about European equities, they may choose to rotate their assets into bonds where they know they can find a guaranteed “risk-free” rate of return.

Here’s what we’re thinking: a 0.27% yield in nominal terms is negative in real terms. Negative real yield means that once the bond matures, the investor will end of losing money.

If global investors can’t buy their domestic bonds and they can’t buy German bunds, then where do they go?

The clear answer is US Treasury Bonds. At the time of writing, the yield on the US 10-year Treasury Note is 2.91%. An important thing to note is that the real yield of U.S. Treasuries after taking long-term inflation into account is just 0.97%. Compared to the negative-yielding German or Japanese Government Bonds (or even gold) a 2.91% yield is pretty darn attractive.

Miscellaneous items

Brexit

There’s still no Brexit deal. I’m not entirely in tune with the happenings of Brexit (which from what I understand is likely for the better), but it feels like the indecision surrounding Brexit negotiations between the May government and the EU is fueling more anxiety and fear in the market than a hard Brexit would. I understand that the issue is far more complicated than that, but that’s just how it feels to me.

We will consider a deeper dive into the Brexit narrative at some point, but for now, we’ll leave it here.

Personal Thoughts

Overall this blog is intended to be an exploration of my thinking and analysis of the world over time. I hope whatever I write here can be informative for others as well. My approach is to continually ask questions about things I don’t understand clearly, because of this my writing contains unanswered questions. I hope moving forward I can develop a community of people who possess a learner’s mindset. Ideally, those who follow my blog are skilled in areas where I am weak so that I can learn as well. My sincere wish is to contribute to the thinking of others.

Tuesday, December 4, 2018

Daily Writing

9:10 AM

Initial impressions of the day

Yesterday we touched on commodities moving higher.[1] Intuitively you’d think that the spike in demand for copper and other base metals would be due to the tentative truce between the US and China. However, we can’t confirm this, and the dramatic downturn we witnessed today could dispel this theory.

2:40 PM

OK so maybe no trade deal

At its lows the Dow Jones Industrial average fell by as much as 800 points, or more than 3.00% on Trump’s sudden wavering views on China. Now, after a brief period of relative clarity regarding US-China trade tensions, that all went out the window after President Donald Trump tweeted that his team would be “seeing wither or not a REAL deal with China is actually possible” by early March, the next deadline in the talks. This uncertainty exacerbated fears that the global economy could be slowing.

Many of the events that the market believed would help improve certainty moving into the new year haven’t panned out. Firstly, there was a widely held belief that mid-term elections on November 6, 2018 would allow the market to price in potential higher budget deficits and adjusted fiscal policy that typically accompanies democratic electoral victory

4:11 PM

OK so maybe the sky is falling

Today was an absolute slaughter in the markets. The SPY fell 3.20%, the DOW fell more than 800 points at its peak, U.S. 10-year Treasuries dipped below 3.00% before settling at 2.91%. Tellier Holdings Apprentice Fund fell 4.28% primarily on weakness in financials and banks. The BLK dividend capture strategy turned out to be a complete disaster. We’ll end up making $70 from the dividend pay out at the end of the month, but on the day BLK dropped by more than 6.00%, something our risk models placed a 0.10% probability on BLK dropping more than 6.00%. Over the past five years BLK has only dropped more than 6.00% on two other occasions, once in late January of this year and once previously in 2014.

Reflections on a -4.00% day

Today was supposed to be a calm day. I had my strategy in place for when things went right. However, I had no contingency plan for when things went wrong. I will shrug off today’s poor result, and I will continue to focus on the basics. I will continue to seek permanence. I must remember to move with the overall trend. Only after I determine, the secular trends should I make trade decisions.

I must be honest with myself if I’m going to improve. I will be accountable. Today’s performance was weak because my risk management philosophy was deeply flawed. As soon as BLK began to drop from 434 down to 424, I felt it was highly unlikely to continue moving further. I added to the BLK position 424.80 because I wanted to capture the additional dividend.

By that point, BLK was already trading down roughly. BLK had only fallen more than 3.00% in a day less than 5% of the time over the past five years.

Unfortunately, I failed to take into account the risks posed to the banking sector Given BLK’s historical volatility and past performance, and I felt the downside would be limited as we crossed the ex-dividend date on Thursday, December 6. I did not anticipate a 5.00% drop in the banking sector with minimal warning, especially given the subdued volatility on Monday.

I felt rushed to decide on BLK quicker than I liked because I knew the market would be closed on Wednesday to honor the late President George HW Bush. I felt encouraged to make this move because I used the same strategy to profit on MCD and TLT. According to my Blackstone, INC. (NYSE: BLK), over the last five years BLK had only experience three drawdowns greater than 5.00%. Today happened to be the second largest draw down, only after the October 10, 2018 decline from which the broader market has yet to fully recover.

Although my mistake cost me roughly 2.00% of my portfolio today, my risk management in the other areas of my portfolio was quite strong. Defensive stocks such as MCD, KO, and SBUX all did their jobs and held steady, all finishing roughly even on the day perhaps even slightly up.

I still do not have a great understanding of the impact of bond prices on overall rates and the profitability of banks. From a macro perspective I am working how the market will behave now that the fear of an inverted yield curve is looking to bubble up.

There are still many things to learn, I feel I can take this experience as a learning opportunity. I am still in the game, and I will strive to improve on my risk management and trading strategy.

Tuesday, November 27, 2018

Daily Writing

8:58 AM

Gold remains rangebound hovering around the $1200 spot price. The price of gold has not moved outside of $1200 to $1235 per ounce since the middle of August.

Oil has started to hold ground at $51.00/barrel. We found an informative clip assessing the current oil pricing situation. In the current environment, which countries have the most impact on the price of oil? Which events or types of events have the most significant impact on the global price of oil?

German bunds move higher, as the yield on the 10-year bund continues to move lower. How are German and other European equities performing? What determines the price of German government bonds? How much impact does the European Central Bank (ECB) policy have on the domestic monetary policy of sovereign European states?

Tuesday, November 6, 2018

Daily Writing

9:21 AM

The U.S. mid-term elections take place today. The outcome is uncertain but there is a strong possibility that the Democrats retake the house of representatives. This opens the door for Trump impeachment in 2018. The markets have not fully priced in a democratic agenda for 2019.

Bond yields reflect the health of a state’s balance sheet. Is this a fair way to approach government bond yields? Brazil’s 10-year government bond currently yields more than 10.00%. Will we see lower yields as newly elected right-wing candidate Jair Bolsonaro’s policies begin to take root in Brazil? Bolsonaro is widely viewed as a right-wing fascist who will be willing to sacrifice capitalism in favor of dictatorship and “rule of law”[1]. At 0.42% Germany’s balance sheet looks quite “healthy”.

Most Asian bond yields are ridiculously low. Japanese Government Bonds (JGB’s) currently yield 0.12%. Isn’t this effectively a negative yield? Why would anyone buy Japanese bonds? (No one does apparently).[2]

The price of WTI crude has dropped considerably since the start of October. What could be the cause of this? Is Saudi Arabia facing heightened pressure to increase demand after the Khashoggi incident? What is the impact of newly enacted U.S. sanctions against Iran on global oil prices?

Volatility continues to tick downward, with the CBOE Volatility Index falling below 20.00 for the first time since September 2018. However, things can change drastically tomorrow following the results of the mid-term election. Our thinking is that the market does not like surprises, if the market is surprised by the election outcome (i.e. Republican victory in the house race), then we could see a considerable spike higher in volatility.

Yesterday European Union Ministers called on Italy’s populist government on Monday to engage in talks with Brussels on a revised draft budget for 2019, backing the European Commission’s view that the plans violate previous commitments by Rome to shrink the deficit next year. The populist Italian government does not view the EU’s terms favorably. What does Italy want to include in its budget that the EU is opposed to? Italy wants to include three things in its budget that fall outside of EU rules: flat tax, reduced retirement age, and citizens’ income. In its current form, Italy’s 2019 budget deficit will balloon to 2.4% of GDP, well outside the 0.8% cap mandated by EU authorities. Things could get ugly here if the issue is not resolved. We are following the deeper impact on the Euro.